Guest Post: QE3 And Bernanke's Folly - Part I

Earlier this year, as the markets were expecting QE3 from one Fed meeting to the next, I was stating another program would not come until September after data for Q2 GDP could be analyzed. However, as we moved into August, and the markets were rallying strongly on "hope" of further balance sheet expansion programs, I moved my estimates out until the end of the year. The reasoning, as I stated, was under the assumption that Bernanke would save his limited ammo for a weaker market/economic environment. Clearly I was wrong.

Much to my surprise, and against all of what seemed logical, Bernanke launched an open ended mortgage backed securities bond buying program for $40 billion a month "until employment begins to show recovery." That key statement is what this entire program hinges on. The focus of the Fed has now shifted away from a concern on inflation to an all out war on employment and ultimately the economy. However, will buying mortgage backed bonds promote real employment, and ultimately economic, growth. Furthermore, will this program continue to support the nascent housing recovery?

Employment - Where's The Demand?

During the Fed's announcement today Bernanke repeated several times that the primary concern of the Fed is now employment. One of the Federal Reserves primary legal mandates is to foster full employment in the economy. However, after two previous Large Scale Asset Purchase programs (QE), and a Maturity Extension Program (Operation Twist - OT), has employment meaningfully recovered.

The chart below shows the net gains in employment since the beginning of 2009 as compared to the number of individuals that have moved into the "No Longer In Labor Force" category where they are no longer counted. There has been an increase of 3.4 million jobs since the lows of mass firings and layoffs post the last recession. That increase is far lower than would have been expected in any normal economic recovery. At the same time, however, more that 8.4 million individuals have just "given up looking for work" or "retired." during the same period. There is NO evidence that bond buying programs have any effect on fostering employment. However, at the current rate of individuals leaving the work force Bernanke could likely get his wish of "full employment" in the next couple of years. Of course, economic prosperity will have deteriorated much further as the rise of the "welfare state" continues.

The next chart shows the number of individuals, since 2009, who are now claiming disability and food stamps.

The point here is the manipulating the bond market, and inflating reserves for the major banks, does not create end demand for businesses. In our recent report on the NFIB survey we stated: "While there has been some improvement since the peak of the "Great Recession" - poor sales still provide an overriding concern for U.S. businesses when it comes to making decisions to increase employment or expand operations. While the concern over 'poor sales' remained stagnant last month the number of businesses saying this is a "good time to expand" fell from 5 to 4 and remains near the lowest levels since the end of the last recession." QE programs do not address the problem aggregate end demand on businesses. In fact, it makes it worse.

Diane Swonk tweeted after Bernanke's comments that: "Fed move to stimulate with open-ended MBS purchases 'unprecedented.' Focus on unemployment over inflation marks new era" While the move may be unprecendented by the Fed to focus on employment over inflation - the chart below shows you that he should be focused on the latter.

From a consumer's perspective the effect of food and gasoline as a percentage of wages and salaries is crucially important. As food and energy consume more of wages and salaries it leaves less available for consumption within other areas of the economy. It is evident that not only do balance sheet programs create inflationary pressures on the aggregate but more specifically in commodity related areas. The chart below shows the consumer conundrum where declining wages meet up with rising costs of food and energy.

It is notable that during the Maturity Extension Program (Operation Twist or OT) the inflationary pressures subsided for the consumer. This is due to the fact that OT did not increase excess reserves at the banks which were then funneled into risk assets. Apart from the recent spike in food prices due to the drought in the U.S. commodities have languished post the last QE program easing consumer pressures in many areas.

The important point, however, is that for businesses to hire employees it will require an increase in aggregate end demand. As the concern over "poor sales" diminish - hiring will pick up. Unfortunately, history shows that balance sheet expansion programs create the opposite effect of that intended by Bernanke. Rising inflationary pressures in food and energy only act as retardants to consumption thereby reducing the need for employers to add to payrolls. With corporate earnings and revenue weakening, rising healthcare costs and taxes on the horizon, and exports slowing - it is unlikely that the Fed's purchases of mortgage back securities will spur businesses to hire.

Housing - Set For A Fall

Bernanke's also stated that by buying mortgage backed bonds he hoped to support the nascent housing recovery. There are two major problems with his thought process that a simplistic look at the data would have revealed. First, and most importantly, is that interest rates have already been at historically low rates and very little housing activity has occurred. The chart below shows our housing activity index which measures the housing components that are most sensitive to the creation economic throughput.

Despite trillions of dollars of liquidity, support programs and "forgiveness" for every criminal act in the book, there has yet to be a real recovery in housing. The most recent upticks, primarily due to speculative investor demand for rental properties, will rapidly dry up as rising interest rates makes buying much less attractive. It is important to remember that people buy payments - not houses. The lack of employment, lower incomes, excess debt and poor credit history will keep a large chunk of the remaining population from qualifying to buy for quite some time. If you couldn't spur a massive house buying binge with the lowest mortgage rates in recorded history - what will another quarter point, or so, actually accomplish?

However, Bernanke's folly is in believing that QE programs lower interest rates. There is no historical evidence that yields fall during balance sheet expansion programs. It is evident, in the chart below, that during liquidity driven programs such as QE, money flows from bonds and into stocks chasing market performance. As a function of this rotation yields have risen sharply during past programs. Only during OT did yields remain suppressed along with inflationary pressures.

Putting It All Together

While the most recent bond buying program will push liquidity into the equity markets pushing asset prices higher - it will do little to help the economy, employment or housing. The evidence is abundant that the only beneficiary of these balance sheet programs is Wall Street. As shown in the chart below the average level of excess reserves for banks was roughly $19 billion from 1984 to 2008. Since 2008 excess reserves held at banks has swelled to more than $1.5 trillion currently.

With the consumer weak, unemployment high, foreclosures and deliquencies still burdensome, and businesses constrained by lack of demand - there is little desire, or need, for credit. This is unlikely to change anytime soon as businesses are forced to pullback even more as demand is further reduced by rising inflationary pressures.

Bernanke was correct about one point - monetary policy has a very limited reach economically and, while up to Congress, it is fiscal policy measures that are needed to promote economic growth. The recent program by the Fed has all but ensured two things from a political perspective: 1) The incumbent President is likely to win the next election, and; 2) that the current gridlock will continue on the fiscal front for another four years.

Clearly, the Fed's actions, and statement, signify that the economy is substantially weaker than previously thought. While Bernanke's latest program of bond buying was done under the guise of providing an additional support to the "recovery," the question now is becoming whether he has any ammo left to offset the next recession when it comes.

So, Fed creates $40B/mo... say, for the next year... Fed uses the new bucks to buy MBS from banks. Banks get to continually de-risk their bal sheet at market (OK, above-market pricing)... and the Fed slowly stockpiles the collateral right to every home, apt bld, skyscraper, shopping mall, retail space in the USA-- Which means China and Japan ultimately do-- another discussion). Banks turn around and give proceeds from selling MBS to their trading desks to gamble in S&P (and sure, dabble some in commodoties). Continual flow of new money to trading desks sends S&P up up up. Smart sideline money sees the inevitable fund flow coming, so time to take a ride-- more inflows to equities (and drain from bonds-- seeing that already)... and eventually even the sheeple see the trend... and they finally (reluctantly) come off the sidelines... more upward price pressure on stocks.

S&P worth appx $13T... add $40Bx12mo is a ~3.7% increase in 1 yr. So if ALL the new money went to the S&P (of course it won't-- there are bank bonuses to pay) there's significant "inflation" pressure on equity values... maybe Tyler / others can weigh in on how much "smart" sideline money is out there (and how much "dumb" money still on sidelines). If they know there's 3% of guaranteed/automatic upward pressure on prices, how can the mob resist riding the train?

You give a good description of the best case scenario. His problem is that he just went all-in and it has to work right. Every downturn in recent years stopped because people became convinced that the Fed would step in an save them. Now they committed themselves and there will be nothing to cause buyers to hop back in. He'd better hope there are no corrections. I still have my short positions (for a bit longer) because I suspect this is not as long lasting as we're led to believe. I'll find out soon.

Let's face it, this latest round of infinite money printing is designed to take bad mortgages off the balance sheet of the banks and put them on the U.S. taxpayer. The mortgages will not be sold ever, but held to maturity. All the while earning "interest" which Bernanke says reduces the deficit! What a joke. They won't be able to reduce the balance sheet and are basically setting us up for that by telling us now that they are going to stay accomodative long past the time the economy recovers.

They think we are all idiots. Sadly, many are not financially not astute and can't grasp the point that paper money has no value with an irresponsible money printer in charge.

I just heard Santelli tell all the bobbing heads that Bernanke doesn't intend QE(all) to help unemployment, it's intended to help the bankers.....they all acted like he told their kid there's no Santa !

What the hell is everyone so confused about? I wonder if someone thrown overboard in the middle of the ocean writes an article on the way down...The guest posts on here trying to disprove the effectiveness of the fed are more delusional than the fed. At least the fed is deliberate, while these moron's keep taking the bait and keep thinking this is just ineffective policy. Like Samuel L Jackson is going to tell you on TV tomorrow...WAKE THE FUCK UP! It's over. Somewhere George Carlin is rolling over in his grave.

That's exactly what I've been thinking. There is some piece of information that is not being shared with us. It scared him enough to pull the trigger what appears to be prematurely. Not unheard of but certainly noteworthy.

I'm sure China is gonna LOVE all the inflation that is gonna be exported.

Remember what help cause the Arab Spring.. QE1 and QE2 which created massive inflation in the middle-east. Now that people are even more pissed and Ben is back at it, the riots/terrorism ain't gonna calm down, it's gonna INCREASE.

I've been wondering if this might have been a large part of the point of this. It certainly isn't to help employment or the larger economy against all evidence; it probably does have a good deal to do with perpetually bailing out banks and raising stock prices for wealthy investors. But those reasons were still there but weren't enough to cause this mass money printing a few months ago. So what's changed?

The main factor is China is starting to collapse, the soft landing is coming way too hard, corruption is being exposed and social tensions are rising - all while food prices are already rising mainly due to the drought so China is withholding stimulus measures. Food prices are likely to rise more in China and other developing nations then the US because of this Fed action, making stimulus directed at specific sectors of their economy impossible for China no matter how much they suffer. We have now pumped out the new money as China's economic bubbles grew, withheld funds as they started to collapse, but are now pouring money in like crazy as soon as its' assured the hot money will affect food prices more then re-flating old Chinese bubbles that have already been exposed. All Fed actions have been the absolutely worst possible moves for China - coincidence?

In looking at how much this really affects our decision making, note these elites are very used to sending many of their own countrymen into die in battles and its' still counted as a 'win' as long as more of the other guys' die. We could be shooting ourselves in the foot in belief that we might be able to get China in the head with the same bullet, as this is the best way to maintain US hegemony in the medium term.

An MBS is an asset with it's value derived from the distillation of unicorn farts. It also violates all laws of physics, since mortgages exist multiple places simultaneously, while the MBSes they are assembled into are sliced and diced to an infinite degree, making it impossible to know exactly where it is, even though it is "legally" bound to the trust underlying it. Yet the trust likely doesn't own it, due to failure to file transfers in order to keep the chain of title intact.

It's kinda like the Heisenberg Uncertainty Principle, but applied to mortgages.

What does he have left.....well his 40 billion a month will turn to 80 billion a month..then to 160 billion a month....and so forth......and I agree..he sees something that he is not talking about.....open ended is the tell all....

This is certainly a big possibility, I don't think he will buy assests that are part of the derivatives implosion that may be already unfolding, but funelling huge amounts of cash to the banks will mitigate that implosion. The good news there is that the extra money the banks get would not go towards commodities and the stock market, it would go soak up the losses in the derivative space, in other words all that extra MBS cash would go to heaven.

If you all recall QEI was huge, it started in late October 2008 and the market still tanked into 666 by early March of 2009.

If what is happpenning right now is a derivative implosion as it did in 2008, that extra cash will go to heaven just as it did in 2008 and the talked about hyper-inflation did not happen................

Two of the areas in derivatives where is the most risk of losses is in interest rate derivatives and Credit default swaps, both are showing bullish signs, if you can call it that as long dated bond rates are going up in spite of all the twisting and jerking he's been doing.

The majority of Americans have no concept of what happened yesterday or even what the Fed is or who Bernanke is. When his ponzi scheme unravels the majority of Americans will be sucker punched and will have never even seen it coming.

Since the timing of the collapse is impossible to determine it will be very severe and even very swifter.

I'm trying to understand better what really happened yesterday. The Fed is going to purchase up to 40 billion a month on MBS's. They are going to purchase them on the secondary market and these securities are implicitly guarenteed with the full faith and credit of the US.

My reading says that half of the Pimco Total return fund (272 bn) are these MBS's and that fund was only up a nickel last night. Why's that ? Is it that the Fed hasn't started its purchase yet and at this point Gross' profits are on paper ?

I understand a mortgage and I understand a portfolio of mortgages. Then there were all those creative products with traunches and synthetics. Do all of these products fall under the umbrella of the 'full faith and credit' ? or does it stop with simple sub-prime mortgages ?

This thought just occurred to me - could this be a twist on California's idea of using Imminent Domain to acquire mortgages and then forgiving/re-working the principal ? Could the Fed corner the subprime mortgage market ?

A clearer, more detailed analysis is needed of what exactly takes place when the Fed buys $40billion/mo of MBS.

For starters, it is assumed the Fed does not have $40billion/mo OTHER than by ctrl-p, i.e. printing new $$.

Secondly what MBSs are purchased? Are they the toxic, subprime ones; and, who will then collect whatever payments result and/or carry out the foreclosures arising under the non paying components of the MBS packages bought by the Fed?

Thirdly, who has the right to receive notice that the Fed is the new owner of this, that or the other MBS?

And, fourthly, how much are JPM and GS going to pocket in all of this?

to state the reason "its about employment" is a complete utter deliberate lie just so they can fool and con the sheeple into not rioting. I could get a two year old that knows its not about creating jobs. This is a backdoor bank/buddies bonus bailout. Call it anything else. If you wanted "jobs" the exact opposite would have been done. We keep focusing on what it means to us. Just wait till it effects a family of four in southeast asia or basically other countries where the living cost creep up to total income. We have a better ability in the states to absorb that unless your keeping score with Ishit.

Bernanke may not have much ammo to 'help the economy,' but probably plenty to reelect Obama. And what did Rumney expect by making clear that he wouldn't reappoint Bernanke?

Much the same thing happened when Gore was first preparing to run for Pres and wanted to have Rubin (sheesh) or a Rubin clone as his Fed chair. Greenspan started lifting interest rates. The Dems quickly realized this was 'not good' politically and Clinton reappointed Greenspan. but the damage to the then internet bubble was done. It didn't take a big needle to pop that bubble, only a sharp one.

Job preservation should go to the top of the list of why Bernanke did what he did.

This is becoming a complete replay of Japan in the 1990s. The central bank of Japan continued to eject money into the banks in this same manner from 1995-2005 and then suffered a 70% drop in their stock market.

Who are the people really running the IMF and World Bank?
How do they get their money?
And what's the difference between the two institutions?
Dollars and Sense magazine
July/August 1999, p41

The International Monetary Fund (IMF) and World Bank are run by their member governments, but not on the basis of one-country-one-vote. Instead, governments have votes based on the amount of money they pay in to the organizations. In this sense, they operate much like private corporations, except that the owners of shares are governments instead of individuals.
The U.S. government has by far the largest share of votes in both the IMF and World Bank and, along with its closest allies, effectively controls their operations. In 1998, the U.S. held 18% of the votes in the IMF and 15% in the World Bank. Together, the United States, Germany, Japan, the U.K. and France control about 40% of the shares in both institutions. With the rest of the shares spread among 175 other member governments, some holding a tiny number of votes, the United States is effectively in charge.
So the people running the IMF and the World Bank are the same folks who run the U.S. government and the governments of its closest allies. Since the institutions were founded at the end of World War II, the president of the World Bank has always been a U.S. citizen, and the head of the IMF has always been a European. These are all men, generally coming from the top of the financial industry.
While the IMF and the Bank operate as extensions of the U.S. government's foreign policy, they are well insulated from democratic accountability. Congress, to say nothing of the populace in general, has no role overseeing their operations, and they operate largely outside the public eye (though Congressional ire sometimes appears in response to a request for more funds).
What the IMF and the World Bank do is lend money to governments. Because many governments, especially governments of poor countries, are often in dire need of loans and cannot readily obtain funds through financial markets, they turn to these institutions. And if the IMF and World
Bank will not loan to a country, international banks certainly won't. As a result, the IMF and the World Bank have great power, and are able to insist that governments adopt certain policies as a condition for receiving funds.
The IMF and the Bank make sure that U.S. allies get the financial support they need to stay in power, abuses of human rights, labor, and the environment notwithstanding; that big banks get paid back, no matter how irresponsible their loans may have been; and that other governments continually reduce barriers to the operations of U.S. business in their countries, whether or not this conflicts with the economic needs of their own people.
In the division of functions between the IMF and the World Bank, the IMF provides funds to governments in immediate financial emergencies and the Bank provides funds for long-term development projects. For example, when the financial crisis that developed in 1997 spread through several Asian countries, capital fled to safer havens. The values of local currencies fell drastically relative to the dollar. Governments (and private firms) whose revenues were in their own local currencies could not meet their dollar obligations to international bankers. This forced governments to turn to the IMF for funds to maintain the values of their currencies and meet their obligations to international banks. Along with the loans, however, came conditions: the IMF's program for economic stability.
The World Bank may receive fewer headlines, not being on the spot in crises, but over the long run it shapes the economies of countries where it makes loans. Its loans cover a wide spectrum of projects, from large hydro-electric dams to local business training programs. Many of the Bank's programs appear desirable in themselves-who would object to dean water facilities, education in animal husbandry, or better roads? Yet the particular projects promote a development strategy that minimizes the role of the public sector, and demands the privatization of communal lands and other public property.
As to the source of their funds, the IMF gets most of its money as subscriptions from member governments-the amount determining the number of votes each government has in running the operation. When, in extreme circumstances, the IMF needs an especially large amount of funds, it can activate a line of credit it has established with governments and large banks.
The World Bank raises its money by taking loans from the private sector, operating through financial markets as would private firms or governments. Because the Bank is backed by funds from member governments, it can obtain private funds at relatively low interest rates. It then turns around and loans this money to the governments of poor countries to support development projects. In effect, the Bank allows governments of poor countries to borrow, through it, on the international capital markets and at lower rates than they could borrow were they to seek funds on their own.
IMF, World Bank, Structural Adjustment

My guess is that too many People have paid off their loans and caused a Money contraction. Which would lead to a down ward spiral.

Many have paid off their Credit Cards and Mortgages. With every Credit Card or Mortgage pay off it creates a reverse of the Money multiplier. Where Money has to be pulled in.

Almost funny with all of the 0% interest rates and everyone is paying off their debt. Yet, why not. You do not get anything in the Bank for your savings. So, paying off debt for any interest higher than .03% makes sense.

P.S. The FED wants People to borrow Money but the Banks will not lend it unless you have Stellar Credit. Which these days is few and far between. Especially, with lost jobs and under employment. Going from a full time jop to a part time job paying less.

uncle benny is very clever lad,,, he knows full well that qe to the nth degree props up asset prices,, he said so many times,, rising prices means happier people , happier people vote for good times,, , obumer,, after election he can say oppps ,, maybe not great idea in real world close shop and do twist 3.0 iinstead,, lots of tools in the tool kit,,, i think there are 12 ,!!! haha

or plan b,, there is something really nasty shite ,,, they know about and are promising to flood the mrkt with cold cash,,,,,, u have europe unimited,,,,,,,US open ended,, same thing different day,,,,,,,, unprecedented,,,,,,,, why know,, things are improving so nicely,,, millions of new job, housing prices rising,,,,,,, why throw gas on a fire, ,,, hummm

"Fed to focus on employment over inflation" ... The last time the FED's focus was on inflation was 1980 with Volcker ... Their only focus is how do we make our member banks whole. If it were on unemployment, they would have done something that would have actually improved employment

These reserves haven't gone anywhere they haven't been 'lent out' into risk assets or anything else. The lending of reserves is the main thesis of inflationists and it does not align with reality.

Reserve amounts never go anywhere, because they are ledger entries not currency. It is as if the Fed credits $1 million dollars to your checking account ... you cannot access that money! It sits there ... unless/until there is a run on the bank. In that instance the $1 million is posted against actual amounts you have on deposit.

What Bernanke has done is guarantee all bank deposits by promising unlimited reserves. Good grief! Isn't that shocking enough? WHY is Bernanke guaranteeing all bank deposits? Why is such a thing necessary?

Whether reserves can be collateral is irrelevant b/c risk assets are funded in money/repo markets and shadow banking using alternative forms of collateral ... or none at all. Risk market players do not need funds from the Federal Reserve they can lend into existence whatever funds they need, re-hypothecating collateral they already possess. This is not news or rocket science: see Joseph Schumpeter.

The real problem besides the Fed's unlimited liability guarantee is the accumulating liabilities in Europe's TARGET2 system. Both of these risks are under the radar, both are likely to bite folks on the ass sooner rather than later. They need to be paid attention to rather than the phantom inflation risks.